Published August 20, 2019|4 min read
When you need to arrange care for a dependent while you’re at work, the sheer costs can take a big bite out of your income. While it won’t relieve 100% of your financial burden, a dependent care flexible spending account (FSA) can help reduce your out-of-pocket expenses.
Dependent care FSAs allow you to pay for care with tax-free funds. If your employer offers a dependent care FSA, participating can save you a good chunk of money every year.
Here’s how to set up a dependent care FSA.
Dependent care FSAs are tax-advantaged accounts, offered as an optional benefit through an employer, that allow you to pay for dependent care. (Read our guide to saving on child care.)
You elect to set aside pre-tax funds from your paycheck in the FSA, which can then be used to pay for eligible expenses (more on that later).
“Rather than paying for dependent care expenses with after-tax dollars, contributing money into a dependent care FSA allows you to pay for those expenses tax-free. In 2019, contributions can be made up to $5,000 for those married and filing jointly, or $2,500 for single taxpayers,” said Drew Feutz, certified financial planner at Market Street Wealth Management Advisors.
The tax savings are the biggest advantage of using a dependent care FSA. It’s usually a no-brainer if your employer offers one and you’d be paying for care anyway.
“If you’re already paying for qualified dependent care expenses, then contributing part of your income into a dependent care FSA could help you decrease your tax burden,” said Feutz.
But participating in a dependent care FSA can only eliminate taxes on expenses up to the annual limit. Any expenses that exceed the limit will still have to be paid out-of-pocket with after-tax dollars. You also must use your funds by the end of the tax year (or grace period if there is one) or you will lose them.
Before you open a dependent care FSA, you need to know if you and your dependent are eligible.
To use FSA benefits to pay for care, you must either be working or looking for work. If you are married, both spouses must be working or looking for work (unless one spouse is disabled and unable to work). The dependent must live in your home more than half the year.
According to the IRS, qualifying dependents must fit the following criteria:
A child dependent who was under age 13 when the care was provided and lives with you more than half the year
A spouse who isn’t capable of caring for themselves and lives with you more than half the year
A person who isn’t able to care for themselves, lives with you more than half the year, and either:
Is your dependent
Would have been your dependent except:
They received an income of $4,150 or more
They filed a joint return
Someone else claims you as a dependent on someone else’s tax return
Eligible expenses include (but aren’t limited to):
Adult day care centers
Au pairs for children
Before- or after-school programs
In-home and center-based daycares for children
Work-related custodial elder care
Registration fees for eligible care expenses
Summer day camp
Transportation of the dependent to or from a location where care is provided
A good rule of thumb is that if your dependents are receiving care that allows you to work or seek employment, it’s an eligible expense. You can’t use a dependent care FSA to pay for care while you go on vacation or go out on date night.
You need to determine if your employer offers a dependent care FSA. If they do, you can set one up during open enrollment season or anytime you experience a qualifying life event as defined by the IRS. Qualifying life events include:
A change in employment status for you, your spouse or dependent
A change in marriage status (e.g., marriage, divorce or death of a spouse)
A change in your number of dependents (e.g., birth or adoption of a child or death of a dependent)
A change that causes your dependent to qualify or cease to qualify as an eligible dependent
A change in cost of care or change of coverage
Signing up will involve filling out some paperwork for your employer and possibly a third-party FSA administrator. You will need to determine how much to contribute to your FSA for the upcoming plan year. You can contribute up to:
$2,500 per year if you are married and file separately (your spouse will also be able to contribute $2,500)
$5,000 per year if you are married filing jointly, filing as single or you file as head of household
Married couples can each contribute to their own individual dependent care FSA, but the annual limit is still capped at $5,000 between both spouses.
If your qualifying care expenses will exceed the annual contribution limit, it makes sense to contribute the maximum to make the most of your tax savings. If they won’t exceed the contribution limit, do your best to estimate your costs for the whole year. You won’t be able to recover any funds you don’t use.
Just like a health care FSA, your dependent care FSA contributions come out of your paychecks throughout the year and go into your account. When your FSA has built up enough funds, you may submit receipts for your care expenses to the FSA administrator. They will reimburse you the funds by check or direct deposit, which may take a few weeks.
You can repeat the reimbursement process throughout the year as funds become available in your account, or wait until the end of the year and claim your entire year’s contributions all at once.
“Typically, you must submit a receipt to reimburse yourself for qualified dependent care expenses that you’ve already paid for. This can often be done through an online portal or by setting up direct payments,” said Feutz.
If you claim an amount that is more than your current account balance, the excess portion of your claim may be carried over into following months and paid out as it becomes available.
Most FSAs have an online management portal to check balances, look up eligible expenses and select how you wish to receive fund reimbursements, such as by check or direct deposit.
Some employers allow a grace period beyond the end of the year to spend the money in your FSA, but it’s not universal. Check with your employer.
Your FSA contributions must be claimed on your federal tax returns by attaching Form 2441, Child and Dependent Care Expenses. You will need to supply information about the expenses as well as information about the dependent and the care provider.
You cannot change your contribution amounts on a whim. You must experience a qualifying event (listed above), after which you have a limited amount of time to change your election.
Participating in an FSA may affect your ability to claim the Child and Dependent Care Credit on your taxes, which is another way to reduce your tax liability (in some scenarios it’s possible to claim both, but not for the same expenses)
You will need to renew your enrollment every year you wish to participate.
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